Credit-default Swap Investigations Are Now Underway

According to an article published this morning on the New York Times web site, New York state and federal prosecutors have now turned their attention to the shadowy and often misunderstood world of credit-default swaps. The Securities and Exchange Commission also recently announced that they were looking into credit-default swaps.

Investigators are specifically focusing on whether or not investors drove up the price of swaps in "transactions that were reported to data providers and never completed." Rising spreads creates downwards pressure on a stock as the cost of protecting their debt rises. So investigators will first have to figure out whether or not there was any manipulation, and if there was, then figure out who benefited.

A credit-default swap is when an investor buys or sells insurance protection against a default on a bond or other company debt.

As mentioned, the first step for NY attorney general Andrew Cuomo and the Manhattan United States attorney Michael Garcia is to figure out whether or not any illegal manipulation took place. The credit-default swap market is quite complex, so the two are first arming themselves with information. They are doing this by issuing subpoenas to companies directly or indirectly involved in the credit-default swap market. The Depository Trust Clearing Corporation and Bloomberg are two of the companies that have received subpoenas so far.

The CDS (credit default swap) market is unregulated and has led to the downfall and/or crippling of a number of companies, including AIG. SEC Chairman Christopher Cox recently stated that the market should be regulated, and the Federal Reserve Bank of New York is apparently pushing forms to "move trading in credit-default swaps to a regulating exchange by the end of the year."

This will be an extremely complicated investigation, and I'm not surprised that New York and federal prosecutors are joining forces on this case. Understanding that complex credit-default swap market is one thing. Showing evidence of manipulation in this market is another. Clearly proving that manipulation and profiteering took place and then securing a guilty verdict is going to be almost impossible, in my opinion. We'll see - they certainly have their work cut out for them.